Government intervention may be needed to burst the huge bubble that has developed in the price of commodities such as food staples and oil, a UN report said.
Prices have rocketed in response to dysfunctional commodities markets, said the report, which also disputes the view of many senior economists and central bankers that commodity prices have jumped as a result of a surge in demand.
“The changing role of commodity markets, which are turning into financial markets, has enormous repercussions for the economy,” said one of the report’s authors, Heiner Flassbeck, a director at the UN Conference on Trade and Development (UNCTAD).
Photo: AFP
Investors are encouraged to behave like a herd, said the report, with few incentives to arbitrage or bet against the tide of rising prices. Without checks and balances in the system, investors create price bubbles that put many basic foodstuffs out of the reach of millions in the developing world.
Oil may be as much as 20 percent overvalued, while maize — the staple food of many developing world economies — is subject to wild swings in price, it said.
In April, the World Development Movement blamed Barclays Capital, the investment banking arm of the high street bank, for driving up prices. Barclays Capital is the UK’s biggest player in food commodity trading and one of the top three banking players, along with Goldman Sachs and Morgan Stanley. It has pioneered the creation of derivatives that -allow pension funds and other investors traditionally barred from commodities exchanges to bet on food prices. Nearly US$270 billion is invested in derivatives that follow commodity prices, up from US$90 billion in 2005, according to UNCTAD.
A separate report by UN special rapporteur on the right to food Olivier De Schutter argued that the appetite for investments in commodities was even higher.
He found that commodity index funds rose from US$13 billion in 2003 to US$317 billion by 2008. While there are no definitive figures on how those index funds break down, one estimate suggested their holdings in agricultural -commodity markets rose from about US$3 billion to more than US$55 billion over that period.
Using these new derivative products, pension funds, especially in the US, have invested large slices of their overall portfolio in commodities as it has become more difficult to generate above average returns from more traditional sources of income, such as stock and bond markets.
UNCTAD, which commissioned the report, said the efficient market hypothesis that many economists believe regulates trading in commodity markets has broken down.
“Another major factor is the financialization of commodity markets, which has played a significant role in price developments in recent years,” the report said. “This phenomenon is a serious concern, because the activities of financial participants tend to drive commodity prices away from the levels justified by market fundamentals, with negative effects on producers and consumers.”
Traders are unaware of other buyers and their trading positions, information that can prove crucial when deciding to buy or sell a commodity.
They said the situation in the EU was worse than the US, where regulators produced weekly reports on rule changes and trends. Largely unregulated over-the-counter markets, which allow -institutions to trade with each other away from the main markets, also needed greater transparency, it said.
UNCTAD said a transaction tax on commodity trading, which could raise billions for investment in developing countries, would slow the pace of financial markets, limiting the scope for misinformation.
Commodity prices reached a record in 2008 as traders anticipated a rapid recovery from the credit crunch of 2007. Critics of commodity traders fear a slowdown in the global economy could trigger a sell-off in commodity derivatives, triggering exaggerated falls in prices.
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